WOLF STREET — It was a perfect gift to a desperate market. All that was needed was a gentle hint that Italy’s troubled banks and their bondholders might not be hung out to dry. A “public backstop” for Italy’s weakest lenders would be a “very useful” measure in these “exceptional times,” ECB President Mario Draghi said.

Most Italian and European bank stocks surged.

The ECB is the second member of the institutional triad formerly known as the Troika to have called for a taxpayer funded bailout of Italy’s banking system. Earlier this month the IMF used its article IV consultation – an annual economic and financial health check – to warn of “global spillovers” from a full-blown Italian banking crisis, “given Italy’s systemic weight.”

Desperate times call for “significant measures,” says IMF economist Juan Toro. These measures include a taxpayer-funded state intervention, a practice that was supposed to have been consigned to the annals of history by Europe’s enactment of new bail-in rules on Jan 1, 2016. The idea behind the new legislation was simple: never again would taxpayers be left exclusively paying to bail out bondholders of Europe’s insolvent banks.

But even before the ink has dried, the new rules are about to be broken, or at least bent beyond recognition. Apparently this is necessary for two main reasons:

a) To save the small investors.Under the EU’s new bail-in laws, Italy’s government can only create a bank rescue package by making bondholders pay for a bailout by converting a portion of their bonds into equity. But roughly one-third of senior bank debt and half of subordinated bank debt, worth a combined total of €235 billion, has been sold, with the government’s overt blessing, to small Italian retail investors and savers, in lieu of CDs. If the bail-in rules are followed to the letter, hundreds of thousands of little people will be taken to the cleaners.

b) To avert a political bloodbath. If hundreds of thousands of Italian retail investors are sacrificed in this type of bondholder bail-in, Italian Prime Minister Matteo Renzi’s chances of winning the do-or-die referendum on changes to Italy’s constitution in October will be further impaired. A public backlash over a bail-in could lead voters to turn to the 5 Star Movement, which has called for a referendum on Eurozone membership. The mere prospect of such an outcome would be enough to trigger a surge in bond yields, credit-rating downgrades, further economic slowing, and added troubles for banks. Oh, and it could be the final nail in the Eurozone’s coffin.

Conspicuously absent from the bleeding-hearts narrative is the even greater risk of contagion to other financial institutions, not just in Europe but all around the world. Almost all the talk is about protecting small-time investors, but what about the big fish?

The Real Risk

The total exposure of French banks and private investors alone to Italian government debt exceeds €250 billion. Germany holds €83.2 billion worth of Italian bonds. Deutsche bank alone has nearly €12 billion worth of Italian bonds on its books. The other banking sectors most at risk of contagion are Spain (€44.6 billion), the U.S. (€42.3 billion) the UK (€29.8 billion) and Japan (€27.6 billion).

Not to mention the more than €200 billion of currency and transferable deposits that international banks are estimated to have exposure to in Italy, or the roughly €150 billion in bank bonds and loans they own.

But not to worry! According to Jay Bryson, global chief economist at Wells Fargo Securities, foreign exposure to Italian banks is “relatively contained” (emphasis on “relatively”). All of which helps to explain why banks and their representatives at the IMF and the ECB are frantically demanding a no-expenses-spared taxpayer-funded rescue of Italy’s banking system.

Leading the charge is America’s biggest bank by assets, JP Morgan Chase.

“It’s necessary to do it [bail out the banks], and the sooner the better, in order to nip in the bud one of the root causes of uncertainty gripping the markets,” said Lucía Gutiérrez-Mellado, deputy director of strategy for JP Morgan Asset Management.

One word that keeps popping up is “flexible” — in particular in relation to the application of Europe’s new banking rules. Here’s JP Morgan Asset Management’s Chief Market Strategist for the UK and Europe, Stephanie Flanders on Bloomberg:

If this is not dealt with in a clear but flexible way, it could be something that adds to the contagion risk, and in many ways it poses a bigger risk to the European economy than Brexit on its own.

Naturally, the interviewer failed to ask Flanders about her own employer’s level of risk exposure to an Italian banking meltdown.

New Opportunities for “America’s Most Corrupt Bank”

Bailing out Italy’s banks is not just about risks; it’s also about opportunities. JP Morgan Chase, which Forbes recently dubbed “America’s Most Corrupt Bank,” is already at the front of the line. According to the Telegraph, JP Morgan has been appointed by the Italian government to work on plans to set up a bank to buy €50 billion of troubled loans from the banks at approximately 20% of face value, so about €10 billion.

The deal would provide not just juicy fees, but also a privileged bird’s eye view of the real health and vulnerabilities of Italy’s largest banks. This might clean up the banks, The Telegraph said, but it “puts the country’s authorities on a collision course with the EU, which does not want taxpayers bailing out banks before private investors take a hit.”

Unless, of course, the risk begins to spread from the periphery toward the core of Europe’s financial system, at the slow-beating heart of which is Germany’s biggest financial institution – and according to the IMF, the world’s most dangerous – Deutsche Bank. Now, with two-thirds of the institutional triad formerly known as the Troika firmly on board with the bailout plan, surely it’s just a matter of days or weeks before the purse strings of Europe’s taxpayers are loosened once again for the benefit of banks, their executives, and their bondholders.